德州儀器 (TXN) 2012 Q2 法說會逐字稿

Good day and welcome to the Texas Instruments second-quarter 2012 earnings conference call.

At this time, I would like to turn the conference over to Ron Slaymaker.

Please go ahead, sir.

Good afternoon.

Thank you for joining our second quarter 2012 earnings conference call.

As usual, Kevin March, TI's CFO, is with me today.

For any of you who missed the release you can find it on our website at ti.com/ir.

This call is being broadcast live over the web and can be accessed through TI's web site.

A replay will be available through the web.

This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations.

We encourage you to review the Safe Harbor statement contained in the earnings release published today, as well as TI's most recent SEC filings for a more complete description.

Our mid-quarter update to our outlook is scheduled this quarter for September 11.

At that time, we expect to adjust the revenue and earnings guidance ranges as appropriate.

Let me start with the market environment.

Revenue in the second quarter landed in the middle of our guidance range with sequential growth of 7%.

Orders grew and backlog expanded, although at a slower pace overall than in the first quarter.

Also, there was a clear downshift in our order momentum in the month of June.

Even though we believe inventory of TI products is low at our OEM customers and distributors, both are reluctant to place new orders and commit to backlog given the uncertainty in the overall economic environment.

This, combined with lead times that are largely below six weeks, has resulted in our window of backlog coverage narrowing, although backlog for July and August has filled in consistent with a typical third quarter.

At this point our visibility is somewhat reduced for the month of September.

This could reflect a range of reasons and potential outcomes.

On the one hand, customers could be anticipating their own businesses to slow.

On the other hand, customers may simply be waiting until the last minute to place orders, given short lead times.

Regardless, as a result of this increased uncertainty, we are being more cautious ourselves in planning for the third quarter and are currently expecting a below seasonal quarter with revenue at the middle of our guidance range projected to be about even with the second quarter.

If customer demand builds as the quarter progresses we are well positioned with short lead times, strong inventory, and available manufacturing capacity to support a higher level of shipments.

Let me now walk through the second quarter's results.

Revenue of $3.34 billion declined 4% from a year ago and grew 7% sequentially.

Analog revenue grew 13% from a year ago and was up 7% sequentially.

The growth from a year ago was due to the acquisition of National Semiconductor and therefore the inclusion of Silicon Valley analog revenue in the second quarter that wasn't included a year ago.

The sequential growth was primarily driven by growth in power management.

Embedded processing revenue declined 15% from a year ago with both communications infrastructure and catalog products down.

Sequentially, embedded processing grew 8%, primarily driven by strong growth in communications infrastructure.

Wireless revenue declined 39% from a year ago, primarily due to lower baseband revenue.

Sequentially, wireless revenue declined 8% due to lower OMAP revenue.

Baseband revenue ticked up a few million dollars to $90 million in the quarter although we expect it to step down to about $50 million in the third quarter as we continue to wind down this product line.

Our other segment revenue declined 4% from a year ago and grew 16% sequentially.

From a year ago, revenue declined due to the expiration of our transitional supply agreements from previously acquired factories in Japan and China.

Sequentially, revenue growth was driven by higher demand for DLP products, as well as the seasonal increase in calculators.

In distribution, resale sequential growth of 7% matched the pace of TI's overall revenue growth.

Distributors reduced inventory levels by a day and are holding a little less than 6.5 weeks of inventory.

Most are waiting until there are clear signs of higher end demand before they are willing to carry more.

Now Kevin will review profitability and our outlook.

Thanks, Ron, and good afternoon, everyone.

As I've done in the past couple of quarters, let me start by walking through some of the charges in the quarter that were included in our reported results.

Acquisition charges in the second quarter were $104 million.

In the prior quarter, total acquisition related charges were $174 million, consisting of $153 million in acquisition charges and $21 million in cost of revenue.

In addition, we also had restructuring charges of $13 million in the second quarter compared with $10 million in the first quarter.

In total, the EPS impact of these charges was $0.06 in the second quarter compared with $ 0.10 in the first quarter.

Gross profit of $1.65 billion was 49.5% of revenue and increased 8% sequentially.

Recall that in that the first quarter we benefited from about $65 million of insurance proceeds that helped gross profit and gross margin.

Operating expenses of $936 million declined about 4% from the first quarter.

At 28% of revenue, operating expenses have moved back into the 20% to 30% range that we target over the course of a cycle.

Our second quarter results included a cumulative adjustment for revision in annual tax rate, as well as a $10 million discrete tax benefit.

Net income in the first quarter was $446 million, or $0.38 per share on GAAP basis before charges.

Again, in the EPS calculation, please note that accounting rules require that we allocate a portion of net income to any unvested restricted stock units on which we pay dividend equivalents.

In the second quarter the amount of income excluded from the EPS calculation was $8 million.

If you don't make this adjustment, you will likely calculate EPS to be $0.01 higher than we have reported.

Let me make a few comments on our cash flow and balance sheet.

Cash flow from operations was $675 million, up $226 million in the prior quarter.

Capital expenditures were $146 million in the quarter, up $43 million from the prior quarter.

I should note that year to date, capital spending has been about 4% of revenue as we benefit from having pulled ahead fab spending through opportunistic purchases over the past few years.

We used cash to repay an additional $200 million of our outstanding commercial paper in the quarter, bringing the remaining balance of this obligation down to $500 million.

We also retired $375 million of maturing debt that he we assumed in the acquisition of National Semiconductor.

We used $300 million in the quarter to repurchase 9.6 million shares of TI common stock and paid dividends of $195 million.

We increased our inventory by $32 million in the quarter, although inventory days declined to 101.

Orders of $3.41 billion in the quarter increased $174 million, or 5% sequentially.

TI's book-to-bill ratio was 1.02 in the quarter.

Turning to our outlook, we expect TI revenue in the range of $3.21 billion to $3.47 billion in the third quarter.

At the middle of this range revenue would be about even with the second quarter.

We expect earnings per share to be in the range of $0.34 to $0.42.

We expect the third quarter EPS results will be negatively affected by about $0.07 of acquisition and restructuring charges, assuming the Company's marginal tax rate of 35%.

For the year, our estimate for R&D expense has been reduced to $1.9 billion from our previous estimate of $2 billion.

Our estimate for capital expenditures is unchanged at $700 million, and our estimate for depreciation is also unchanged at $1 billion.

Our estimated effective tax rate has been reduced to 26%, down from our prior estimate of 28%.

In summary, although our financial results for the second quarter were consistent with our expectations, our visibility into the third quarter's demand has been reduced.

We remain focused on strengthening our long-term position in analog and in data processing while also staying sensitive to the twists and turns of near-term demand.

With that, let me turn it back to Ron.

Thanks, Kevin.

Operator, you can now open the lines up for questions.

In order to provide as many of you as possible an opportunity to ask your questions, please limit yourselves to a single question.

After our response we will provide you an opportunity for an additional follow-up.

Operator?

(Operator Instructions)

Jim Covello, Goldman Sachs.

In terms of the utilization rates that you're expecting as you go through the third quarter -- I guess that would be the first question.

The follow-up, so then I can go away after that, is there ever a cost benefit analysis that would make sense to shutter some of the strategic capacity?

In other words, if the expectation is that it is going to stay dormant for an extended period of time, would it make sense to shutter it, then bring it back on-line when the utilization is picked up?

Thanks very much.

Kevin?

Jim, let me start on the utilization in the third quarter.

I think implicitly -- we don't normally forecast that, but implicitly with the revenue guidance being flat and inventory being at desired levels, about 101 days right now, I don't expect our utilization level to be going up at this stage and in fact might even decline a little bit as we go into the quarter.

As to the second question on the cost benefit of shutting down strategic capacity, you may recall that back in January we did announce the closure of two older factories that from a cost benefit standpoint the economics of upgrading or trying to improve those factories to compete with some of the newer factories we brought on-line just didn't pay.

So the decision was to go ahead and wind the operations in those factories down.

That's one factory in Houston which we expect to close by the middle of next year, another factory in Hiji, Japan which we expect to close by the end of next year.

Okay, thank you for your questions, Jim.

Next caller, operator.

Stacy Rasgon, Sanford Bernstein.

First of all, just looking at the outlook, so flat revenue guidance, EPS up a little bit, sounded like you said utilization down which might imply that gross margins may be down a little bit.

So is the EPS savings here all OpEx or is some of it gross margins, or is it split between the two and could you give us some color on the drivers between -- for gross margin and OpEx into Q3?

Stacy let's, just for correction purposes, at the middle of our guidance range our revenue is flat, and our EPS is also flat at $0.38 on a GAAP basis.

Pro forma sounds like a little higher, though, right.

$0.01?

Yes, because we have an extra -- in spite of that flat GAAP EPS, the charges will -- think of it more rounding up to $0.07 as opposed to rounding down to $0.06 in the quarter.

Do you have any other --

On that first question then, does that imply sort of gross margin and OpEx flattish to Q2?

Kevin?

Yes, Stacy, when you build your models and make the adjustments for the various things we were just talking with Ron about, I think you'll see the gross margins are probably going to be a little bit better.

We'll have a bit of better mix we would expect in 3Q.

Recall the seasonality of our calculator business, for example.

Third quarter tends to be the strongest quarter and that has fairly good margins.

As Ron mentioned, we'll see the baseband drop to probably about $50 million coming off of $90 million last quarter.

And so the remaining revenue that will fill in that gap has slightly higher margins.

So between those things I think you will see the margins probably up a little bit quarter over quarter.

Got it.

That's helpful.

And for my follow-up, so you mentioned, I guess, limited visibility in September in regard to your customers.

What kind of September outlook do you actually have baked in right now to your flat guidance and where could this go if we had a normal September as we seemed to have like a normal July and August orders right now?

Well, Stacy, a normal seasonality for us in third quarter is to be up, on average, seasonality is to be up 6% quarter over quarter.

So one could say that if, in fact, September fills out in a more normal fashion, we might see growth rates approaching that sort of number.

But as Ron mentioned and as we've been talking about in the press release, given the profile of the backlog that our customers have scheduled on us we clearly have less demand scheduled in September right now than we would normally have at this stage in the quarter, and that's caused us to be cautious on our guidance because it's really not apparent to us why that is the case.

Again, is it because customers fear their end demand or, in fact, do they just have increased confidence that if their demand goes up we have adequate inventory that we can meet short lead times?

Stacy, thank you for your question.

Let's go to the next caller.

Sumit Dhanda, ISI Group.

Could you tell us exactly what your lead times are?

In other words, if you did end up seeing that pick up for September, what sort of a last date by which customers need to place orders so it actually impacts your revenues in the third quarter?

Sumit, one way of thinking about it is, I think we mentioned the vast majority of our products have lead times less than six weeks.

So that would say certainly -- and some of that goes all the way down to zero if we have in-stock inventory, but certainly that would indicate that by the time we get to our mid-quarter update in September we'll have certainly better visibility as to what the month of September should be looking like at that point.

Did you have a follow-on?

Along the same lines any -- clearly June orders were significantly weaker than you might have expected.

Has there been any pickup or stabilization in July?

Was there any difference in the profile of orders you got, for example, from your distributors versus your OEMs ex your wireless OEMs?

Thanks.

I'll answer the first part.

Kevin, I'll let you handle the second part if you remember it.

In terms of July, the rate of new orders in July really, Sumit, is consistent with what we saw in the month of June.

So we haven't really seen a pickup, but we also haven't seen a further slowdown.

So our guidance does comprehend those order trends.

And, Sumit, as it relates to the distribution channel, for example, what we saw in the second quarter was distributor resales actually increased quarter over quarter to about the same rate of TI's total sales, so that was consistent, and their inventory dropped about a day.

So they continue to hold very lean levels of inventory which suggests to us that similar to our OEM customers, they're holding only as much inventory as they feel they need to have for relatively short windows of time, 6.5 weeks as I mentioned.

So it goes back to what Ron was saying earlier.

Our customers across the board seem to be carrying very lean inventories, expecting to us be able to meet very short lead times which we presently have available, so we should have better insight as to what their final demand will be for third quarter when we get to the mid-quarter update.

Thank you, Sumit.

Let's go to the next caller, please.

John Pitzer, Credit Suisse.

Quickly on the wireless profitability for the June quarter.

I would have thought with a better mix of baseband that op profit would have been a little bit better.

So I wonder if you could help me understand what's going on there, and importantly ex baseband, what's the revenue you need to see for break-even op profit in the OMAP and the connectivity?

John, the biggest thing driving the profitability, or quite frankly the lack of profitability right now in wireless is the revenue.

This is a revenue-dependent business, as we've talked about for a while.

There's a large R&D build going on inside that segment as they develop new products for the end markets they're aiming at.

It really has been one that requires more revenue than it obviously has today to absorb that much R&D.

It has clearly got our attention, and it's something we're looking closely into.

As it relates to a break-even number, I would just remind you that back and forth quarter that revenues that that segment turned in was actually about break-even at that point in time if you adjust it for baseband.

So that's probably your best reference point.

I won't try to forecast going forward.

As you probably well know from our conversations here in the recent past, we're looking at the opportunities for that business to expand product offerings into the embedded processing space and that clearly will have a different profile of needs as we get all that planning worked out.

So Kevin, just to make sure I heard right, you're saying fourth quarter of last year the non-baseband part of wireless turned a profit, a small profit, and that would be the closest proxy.

Okay.

Right.

Very good.

Did you have a follow-on, John?

Yes, Ron.

Quickly, you talk about baseband being down to $50 million in the September quarter.

Just relative to kind of your midpoint of flat revenue, are there any broader revenue buckets that are outperforming or underperforming that you can talk to, or is everything coming in kind of flattish?

I would say for the most part flattish.

We don't break the guidance down too much by product area, but as Kevin mentioned, clearly there's a seasonal trend where our calculator business tends to grow third quarter compared to second quarter.

So we would expect that, of course, to occur and be -- and it probably largely offset the decline in baseband.

Outside of that, certainly collectively flattish, but generally flattish by product area as well.

Okay, John, thank you for your questions.

We'll move to the next caller.

Christopher Danely, JP Morgan.

Just to follow-up a little bit on the wireless group.

Are the R&D cuts in the second half, are those all aimed at wireless?

Then is there some sort of timeline to where we can tell that, say, if wireless isn't profitable by Q1 of next year then there could be some changes there?

And what are the options if wireless does not become profitable within a two, three quarter time period of changing the business?

Chris, I don't think anybody said anything about cuts in the second half.

I think what we talked about was that we are looking at how to best align the resources to meet the change in market opportunities we see for those products, especially in the embedded processing space.

And that can include also reallocating resources to other areas where we have better growth opportunities.

And I don't have any numbers for you with specificity as to what a break even or how much time that may take and so on.

That will all come with time as we decide what the appropriate actions are, if any.

One of the things you were referencing, Chris, was just the fact that we lowered the guidance.

Think of that more as anticipated growth that we had planned overall in R&D will not be in the plan or won't be occurring now.

And for the most part, if we hold second half quarterly run rates consistent with where we were in second quarter, then we would probably be rounding down to that $1.9 billion guidance that we gave for the full year.

Did you have a follow-on, Chris?

Yes.

Real quick on SVA -- it was flat, and the rest of your analog was up.

Was there anything going on there and do you have any outlook on SVA versus the core TI analog for the second half or at least Q3?

Yes, there is some stuff going on with respect to SVA but it really tied more to fourth quarter and first quarter.

You'll recall in those quarters we were talking about we had made some distributor changes.

I think in fourth quarter we had eliminated one of their traditional distributors, and then brought them on to additional distributors that had previously supported TI in the first quarter which resulted in some inventory adjustments in the channel.

So think about first quarter for SVA benefited from some channel fill with inventory, and therefore the comparison is a little more complex or unfavorable than going into second quarter.

So really that's the only difference.

If you look from a resale perspective, SVA resales were very consistent with what you saw or what we described for the rest of TI.

So again, it's just more noise associated with the changes fourth quarter and first quarter with respect to distributors.

And Kevin, was there an additional part of the question?

No.

Very good.

Thank you, Chris.

We'll move to the next caller.

Tore Svanberg, Stifel.

First question is, during the mid-quarter update, you talked about the wireless infrastructure or call infrastructure and automotive actually holding up.

Could you elaborate a little bit on that comment now, the way you see things now, and is there any market at all that could potentially be up sequentially in the September quarter?

Sure, I can talk about the coms infrastructure.

I think automotive, we ended up just from a sequential standpoint with second quarter being down slightly.

So that shifted a little bit during the month of June from our prior expectations.

But coms infrastructure had very strong sequential growth in the second quarter, and it's really more of what we have described previously, which is in the North America market, there is a very aggressive build continuing to take place as carriers just try to stay up with consumer demand for data.

And so with everybody having smartphones and tablets consuming lots of data, the carrier is under a lot of pressure just to be able to stay up with that demand, given the strength of our position across almost all of the equipment manufacturers, we're a prime beneficiary of that.

So again, you can say that LTE is starting to come into play a little bit, but really this is mostly being driven by 3G, really WCDMA builds here in the North America market.

We see that trend on a secular basis continuing going forward, although once we get really toward the end of this year, you will see more of the carrier spend start to shift to small cell.

Macro doesn't go away, of course, because those base stations are still required, but on the other hand, a bigger part of the carrier spending will likely begin to shift towards small cell where we have an extremely strong position with our system on a chip and we look forward to that.

But again that will start here in the North America market.

I think it's already begun in some markets like Korea.

It will start here in North America late this year, and really we think will ramp nicely from there.

So again, good secular trend for us there ongoing.

I think in the automotive space, the only thing I would say is that I think that market, as you might expect, with economic uncertainty, consumers expressing more concern on where they spend their money, especially on large purchases like automotive, we're starting to see some of that as well as I assume other players will as well.

Did you have a follow-on, Tore?

Just for Kevin.

The R&D coming down a little bit for the year, is that sort of as a response to the environment, or have you seen some consolidation programs?

Just trying to understand where that's coming from.

Yes, Tore, that's a little bit of response to the environment but it's also, on a lowered outlook, some variable compensation, for example, will be less than it otherwise would have been.

So I would say it's a combination of some temporary and permanent adjustments.

The permanent, if you will, was that the expected variable compensation would be a little bit less than we previously planned, and some of the permanent is just realigning some of the programs that we had underway.

Great.

Thank you.

Thank you, Tore.

Next caller, please.

Glen Yeung, Citi.

Can I just ask a little bit about the border linearity between June and July?

Because it sounds like June was very bad but July is back to normal seasonal.

My suspicion is that tells me more about June than July, so in your response can you also describe what exactly happened in June?

Let me make sure that you didn't misunderstand what I said before, Glen.

July in terms of new orders coming in, really is about the same level that we saw in June.

So is it hasn't picked up, nor has it slowed down.

What I did say is that our backlog coverage, meaning orders that are scheduled to ship in the month of July, looks pretty typical.

But in terms of new orders, they fell from May to June, and July is running at about the same, just call it daily run rate that we saw for the month of June overall.

So not a change one direction or the other, but again, it's the combination of what we saw in the month of June, as well as what we see month-to-date in July that has led us to give the sub-seasonal guidance that we provided.

Did you have a follow-on, Glen?

Sort of, as part of that.

What exactly did you seen June?

Was there any sort of pattern in terms of geographies getting weak or end markets getting weak, or was it just everything across the board?

I would say pretty broad based.

There were some markets that shifted maybe a bit more than others.

I don't know so much from an order standpoint.

Maybe this is a little different twist on your question.

But from a revenue standpoint, probably -- let me just kind of walk through the regional results.

The North American market from a sequential growth standpoint was strongest, followed by Asia, followed by Japan, and then Europe actually was the only region that was down a little bit.

At mid-quarter update I believe I described at that point we were expecting some growth out of Europe.

So at least from a revenue standpoint there was a little bit more of a downshift in Europe, probably no real surprise there.

I don't know, Kevin, is there anything that jumps to your mind from a product line standpoint or from an end market standpoint?

I would describe it as more broad based, Glen, as opposed to any particular area of weakness that was pronounced.

I would agree.

If you look across the whole quarter, you could probably say most of the end markets were up a bit.

Auto and TV were down a bit, as Ron mentioned earlier, and the industrial space, probably about flat on a quarter-over-quarter basis.

That's kind of the mix we saw in the major markets.

So Glen, I think you were describing that as 1a and 1b on your question list and you still have number 2 coming so if you're still there, do you have a question?

Yes.

It's a very, very simple one.

Do you happen to know what utilization rates were in the June quarter?

The answer to that is also very simple.

Yes, but we do not disclose those specifically what our utilization is.

I think Kevin said our utilization overall was up slightly second quarter to -- compared with first quarter.

Similarly the underutilization charges were therefore down a little bit.

But frankly, as we got into the month of June and saw orders fall off, we changed our loadings, we pulled back on our loadings, and as a result, the underutilization expense did not fall quite as much as we had expected, which you see in a gross margin which frankly was not quite as strong as we had expected in the quarter as well.

Okay, Glen, thank you for your questions.

We'll move to the next caller.

Joe Moore, Morgan Stanley.

Thank you.

Keep pushing on this wireless question a little bit.

In the fourth quarter of last year you had a big high-profile tablet win that helped the OMAP business.

I have that business down, ex baseband I have wireless down a couple hundred million from the last couple quarters.

I may be wrong on those numbers.

Do you have the types of OMAP opportunities in the next two, three quarters that can get you back to that level, or is this more of a kind of waiting for the embedded business to fill in those gaps to get back to that level?

I think it's a little bit of both.

I mean, clearly in the tablet space, we have other customers wins that you can assume will be ramping into production using new products, new OMAP products from TI before the end of the year and just where those go in terms of actual success in the marketplace is still to be determined, but clearly there's opportunity there.

And at the same time, as you've heard us say now for several quarters, we're not resting, waiting for the tablet or smartphone space to carry us.

We are rapidly pursuing opportunities in the embedded space, more horizontal opportunities outside of smartphones and tablets, and those are showing good traction as well.

But there's clearly opportunity for growth in smartphones and tablets as well.

Did you have a follow-on, Joe?

Sure, thank you.

The Windows 8 on OMAP in the wake of Microsoft Surface coming out with their own Windows 8 tablets on a competitor's ARM chip, what's your customer's interest in continuing to pursue that market or is it a big investment for you guys?

It is an area that we're pursuing.

We have Win RT ported over to our OMAP architecture, and we think that will have opportunities not just in the tablet space, but also in some of the embedded opportunities that we're pursuing as well.

So a lot of those embedded opportunities are going to be looking for high level operating systems to run on our applications processor and the fact that we have the broadest coverage of any applications processor in terms of high level operating systems that are ported and running on our chip is differentiation for TI and opens a lot of doors for us.

So in terms of the customer enthusiasm, I can't speak for the customers other than to say we see a lot of activity from those customers in terms of preparing to launch their own products.

So we assume their enthusiasm is unabated.

We'll see where it goes.

Okay, Joe.

Thank you.

Let's move to the next caller.

Patrick Wang, Evercore Partners.

First question.

You talked about Europe softening since you gave the mid-quarter update.

I'm curious, you've seen a stabilization in that area, and what's your latest read on that?

I'm not following your question.

We've seen a stabilization in Europe, you're saying?

Yes, I'm curious, when you said relative to your mid-quarter update, the one geography that seemed to have softened a bit that wasn't necessarily surprising was Europe.

I'm just curious, with your more typical month of July, if things have stabilized there, and you guys are looking for more constructive type of trends going forward, or is that still an area where it's still softening?

Patrick, I would say it's probably too early to tell.

Recall that in Europe it's customary that many of the businesses there take mass vacations during the summer months, especially in August, so typically you don't see much resumption of meaningful demand in the third quarter from Europe until you get to the end of August, so it's probably too early for us to comment on that just yet.

Did you have a follow-on, Patrick?

Got you.

Yes, I do.

It's really about gross margins.

If we look at gross margins going forward here, it sounds like you guys are guiding margins up slightly here in the third quarter, but as we look into the back half into next year, what are some of the structural things we should be thinking about in terms of getting the margins back into low to mid-50s?

I think the most apparent one is revenue growth.

As we've been talking about, we did bring in quite a bit of capacity during the last couple years that we bought for literally pennies on the dollar.

Even though it's inexpensive, nonetheless it does still contribute to our underutilization charges in the quarters.

Clearly the most meaningful way for us to improve gross margin is simply to continue growing our revenues so that we can absorb that underutilization and it will fall through to gross margin.

In addition to that we'll see a continuation of improvement of mix.

As we talked about earlier, baseband will drop to about $50 million we think in third quarter.

We still expect that to wind down to essentially zero as we begin 2013.

That will be replaced -- revenue that replaces that tends to have higher gross margins.

So there will be a little bit of mix inside there but I think the biggest driver to point to is revenue growth to absorb the underutilization.

Thank you, Patrick.

Appreciate it.

Next caller, please.

Doug Freedman, RBC Capital Markets.

In the past, Ron, you guys have been able to offer some color on what's going on in the PC market, specifically the disk drive market.

There was a lot of movement this quarter.

Can you give us an update on what you're seeing right now?

Sure.

I guess what I would say is we saw some growth in disk drives in the second quarter, and there probably was still some residual recovery from the Thailand flooding, but certainly going out of second quarter we think that is now fully recovered.

Our view overall of that hard disk drive TAM, it appears to be softening somewhat.

That very well could just be the mix of the types of computing platforms that are shipping, and many of those not using hard disk drives, they're using solid-state memory at this point.

I think other than that -- I think I described at the mid-quarter that we had seen some mixed signals in the PC space between maybe some of what we're seeing with analog products, battery management, et cetera, and what we were seeing with hard disk drive, and I'd say that that still held through the end of the quarter.

Did you have a follow-on, Doug?

Yes.

If you could, could you guys give us an update on how the progress of your not-so-recent acquisitions, the CICLON, Luminary.

I know you've commented on Silicon Valley Analog already.

If you could go back a little further and highlight how well those businesses are working within your portfolio.

Doug, you may recall, or for others who are listening, CICLON was supporting the power strategy inside analog, and I would say by all indications that has turned out to be quite an effective acquisition and contributing nicely to growth in the power space.

Luminary was an acquisition that went into our embedded processing side of the house and really gave us capability in the 32-bit microcontrollers that we previously didn't have a strong footprint in, and we're learning a lot in that space.

Looks like we've got a lot more opportunity, a lot more growth to do there, but clearly that brought a lot of knowledge to us and filled in some gaps that we didn't previously have in-house.

Okay, Doug, thank you.

We'll move to the next caller, please.

Vivek Arya, Bank of America Merrill Lynch.

I wanted to ask about underutilization charges.

Especially, is that mostly a cash charge, is that a non-cash charge?

Would there necessarily be an uptick in gross margins if you were to just conceptually, say, shutter 5% or 10% or whatever of capacity?

The question really is, what is really the cash drag from these underutilization charges?

Vivek, the underutilization charge is -- there's probably a little bit of cash in there but these are mostly non-cash.

You're talking about assets that are depreciated or not being used.

These are mostly non-cash.

There's going to be some cash because you're keeping, of course, underloaded clean rooms open so you're still using utilities and some gases and so on to keep those going, but that's minimal.

As it relates to opportunities, when we described in January that we were closing two of our older factories, the one in Houston and the one in Hiji, Japan, what we talked about is once those factories were closed they should save us about $100 million in costs on an annual basis once that's done, so that's by the end 2013.

So those are the kind of numbers that you can think about in this area.

Did you have a follow-on, Vivek?

Yes, thanks, Ron.

I'm wondering why your operating margins in the embedded side have lagged.

Is it mix, is it more because of the wireless infrastructure business not doing so well?

Because your analog margins seem to have recovered somewhat to the mid-20s, but the embedded operating margins are down substantially year on year.

what you've got going on, year on year you've got revenues down also, if I recall.

Let's take a look.

Yes, revenues down about 15% year-over-year so you've got underlying R&D and support costs that are still there and revenues down so that's going to take your margins down.

But in the quarter itself is probably a bit below what we had expected.

Really, that's being driven by some new product start-up and some inventory scrappage that occurred in that segment in the second quarter.

Thank you, Vivek, and let's move to the next caller.

Craig Ellis, Caris & Company.

Thanks for taking the question.

Maybe I'll just pick up on that last question.

If we look at embedded processing profitability going forward, how should we think about the rate of growth in profitability versus the rate of growth in revenues (inaudible) or are there any projects coming up?

Craig, I think you were fading out there.

I think you were questions about how to think about the rate of growth in embedded processing.

Embedded processing rate of growth of profitability versus revenue going forward.

Similar to analog, we would expect the embedded processing space to grow kind of at a historical average which would be probably in the 8% kind of range over time.

In fact, if you take a look inside embedded processing, and where we're aimed at, at the 16 bit and 32 bit, those are growing a bit faster than the 8-bit portion of embedded processing, so you might see something compound a little bit faster than that over time just from a market standpoint.

And of course, you know our stated objectives are to grow faster than our markets so we put the resources down to do that.

Clearly with the operating expenses inside that segment, all things being equal being fairly stable, any growth in revenue should fall through pretty quickly and improve profitability so you would expect growth in revenue to occur at a certain pace.

Growth in profitability would occur at a faster pace just because it's falling through without too much incremental operating expenditure.

Did you have a follow-on, Craig?

Thanks for that, Ron.

On the follow-up we've talked a lot about reduction in R&D expense for this year.

What about selling, general, and administrative?

Should we expect that to be lower than the trajectory you were looking at in the first half of the year?

Yes, on the general and administrative costs, we already have actions underway that we talked about when we acquired and closed on the National Semiconductor acquisition.

You may recall that we talked about, by the end of the first year of the acquisitions, that's going to be sometime in the fourth quarter, that we will be removing redundant costs between the two companies, such that we should have about $100 million of annualized savings after the end of the first year.

We're actually making pretty good progress on that front.

You may or may not be aware but back when we closed on the National acquisition, we put some pro forma P&Ls out on the Investor Relations website that you're welcome to go take a look at that helps you see what the two companies would have looked like had they historically been combined.

If you go take a look at those, I think you'll find it somewhat insightful to just take a look at 2Q '11 and compare that to our most recent quarter and you'll see that we're already beginning to see some of the cost synergies of the merger of the two companies coming together showing up in those results.

Craig, Kevin, do you happen to have a number on how that SG&A compares year-on-year?

Sure.

Looks like the combined SG&A for the to companies on a pro forma basis last year would have been about $478 million, and in 2Q we just did $457 million.

So you're running about $22 million better on a year-over-year basis.

Okay.

Thank you Craig.

And we'll move to the next caller please.

Ross Seymore, Deutsche Bank.

One clarification from what you just said, Kevin, at the $22 million ahead of where you were before, is that fair to then say you have $3 million more, then you're at your $100 million total with the synergies?

We would expect to get the rest of it over the next few months, yes, Ross, and really what's coming down there is recall that on our way there we're having to spend a little to save a little, so to speak.

In other words, just integrating the IT systems is causing us to take on incremental costs to get there.

I think it's pretty safe to say that we can see on the radar that we'll deliver that $100 million of annualized savings by the end of the year.

On the disty inventory side of things what's your assumption from what the channel does inventory-wise in your third quarter guidance?

Ross, we may have some assumptions but we don't publicize those just given -- distributors will do what they feel they need to do based on their own views of customer demand, but usually we'll try to provide some insight at mid-quarter update but not this early as to what we expect those trends to be.

So that will be the first question.

And you still get another one.

Go ahead.

Thank you.

You're in a generous mood.

Calculators you mentioned is a positive outlier for the third quarter.

Could you give us an idea, how big was that in the second quarter?

Did it go up its typical, whatever it was, $75 million and then how much does it typically rise in the third quarter?

It was pretty typical, and I'm trying to remember what typical is.

Hang on a second.

It did increase about $70 million or so, second versus first, and it customarily goes up pretty close to the amount of decrease that we're going to see in baseband in second to third.

Baseband was about $90 million in second, and we expect it to drop to about $50 million.

That's not that far off from what we typically see the calculator business go up from second to third.

$30 million to $40 million type of increase in calculators, typically.

All right, Ross, thank you for your questions.

We'll move to the next caller, please.

Chris Caso, Susquehanna.

I want to take a step back with respect to the third quarter guidance.

Typically if we look in the third quarter and we're seeing a subseasonal third quarter, it's typically because there's some inventory to burn in the channel.

When you look at the seasonal businesses, I would imagine there's still some seasonal build going on, it's just more muted than normal.

If we were to get towards the low end of your guidance that would actually imply somewhat of a seasonal decline, sequential decline.

Could you help me to get there what potentially could drive that?

Is there still some inventory burn going on in the channel, perhaps there's something going on with pricing or some of maybe the non-seasonal market segments?

Chris, I would make a couple of points.

I think inventories are low already so this is not a case where in second quarter a lot of inventory was built, and now there's potential need to replenish.

That's not the situation that we see.

We think what happened in second quarter, the growth that came about, was not inventory replenishment but was simply customers for the most part no longer reducing inventory and so, therefore, our shipments are necessarily needed to start moving back up to the rate at which the customers were producing their own product.

So not inventory build, but rather the end of inventory depletion.

And you can see, as we said, the distribution channel at -- even at 6.5 weeks of inventory, which it's been for the last few quarters, was low already, and yet they did manage to take it down another day as we mentioned in the second quarter.

So again, I think our third quarter scenario, I don't think the downside case, or the lower end of the range case has to do with inventory burning.

I think it has more to do with if the macro environment weakens and customers take their own production rates down, or down from what they are currently expecting that could come into play.

And, of course, the upper end of the range just would reflect that customers that today haven't filled in the September orders, just hadn't placed those orders yet because they didn't need to, based on where lead times were.

So that would drive the upside case.

The middle of the range case is kind of what we see in our backlog now and not making a lot of assumptions that we get additional fill-in during the month of September.

So hopefully that helped.

Do you have a follow-on, Chris?

Sure.

Just as a follow-up on that then, embedded in your guidance, assuming the midpoint of the range, is it fair to assume customer inventory and distributor inventory would be relatively flat quarter over quarter, in dollars?

Boy, it's kind of what I was saying before.

I don't know that we -- I guess to some degree that may be the case in that we're not seeing signs, in the form of backlog, signs of a ramp during the month of September that you might would more typically expect, just given the upcoming holidays.

So I guess you would say at the middle of the range there's probably the assumption of flattish inventory but I don't know that we put a lot of assumptions about customer and distributor inventory into that guidance more so than just thinking about overall demand.

Okay, Chris, thank you for your questions and we will move to the next caller.

Tristan Gerra, Baird.

Could you talk about OMAP as a percentage of wireless in the quarter and what was the magnitude of the sequential decline and whether you expect some rebound in Q3?

Well, OMAP, I think first half overall has run about 60% of the non-baseband revenue.

So, in other words, OMAP plus connectivity, is kind of a 60/40 split with OMAP being 60% of that revenue and 40% being connectivity.

So from there you can probably get pretty close in terms of what those trends were, but clearly the decline was driven from OMAP.

The connectivity was down but I would describe down a small amount compared to OMAP.

Did you have a follow-on, Tristan?

Sure.

Could you give us, based on your pricing strategy for SVA, in terms of your target of getting back to the core growth that you have in your analog business?

You said for SVA?

For your Silicon Valley Analog.

Yes.

I think the pricing strategy is going to be consistent with TI's own pricing strategy in the catalog spaces like high-performance analog and a good part of the power product line which is, we want to be competitive in terms of pricing, but at the same time, those markets, you tend to sell into, not always, but a lot of relatively low volume applications, where the focus from the customer perspective is much more on the product specification, the performance characteristics of the product as opposed to price.

These products in general tend to be relatively low-priced products, meaning less than a dollar type of ASP, and so as a percentage of the customer's bill of material, it represents a pretty small amount.

So customers for these products tend not to be hypersensitive on price.

They're more focused on getting the right type of product and I think with the strength of the product line portfolio that SVA has, the focus is much more on getting the word out, getting the support out to a much broader range of customers and making sure, of course, we're competitive on price.

We're certainly not going to go out and try to position the product line so that it's not competitive.

And frankly, that was part of the issue in terms of that revenue growth before, was reaching for higher levels of gross margin.

Sometimes the pricing out of national was not competitive in the marketplace, and you saw their market share loss as a result.

So the strategy shift is just make sure you're competitive, but again, make sure we're winning products based on performance and support considerations as opposed to pricing.

Okay, Tristan, thank you for your questions.

And we'll move to the next caller, please.

Romit Shah, Nomura.

Ron, looking at your sales guidance this quarter, it seems a little bit worse than what some other companies have reported thus far in July.

If I look at Intel, they guided up 6% which is a couple points worse than what they normally do in Q3.

Xilinx, if you look at their core business being down a couple percent, that's also maybe 1 or 2 points worse than what they normally do in Q3.

Your third quarter flat I think is about 6 to 7 points below what you normally do, so I'm just curious what is it about this environment that's hurting you guys a little bit more.

Romit, my guess -- first of all, Intel probably has just a different type of seasonal pattern.

They certainly are much more narrower in terms of their end market exposure.

So I'm not sure that we can do much of a direct comparison there.

And then I think similarly, you know, Xilinx, if we were just looking at our coms infrastructure trends they might be different than what we see for overall, and clearly they're going to have a much stronger part of their mix tied to coms infrastructure.

I think of all the companies, at least the ones you've named, our exposure is probably much broader than any of them.

The second point is, we really are operating in a more uncertain environment and as we said, this is a question not of the backlog is painting a very clear story and it's a negative story.

This is more a question of we don't have all the backlog visibility that we would normally have, and so in that type of environment, and I think a lot, from what I've seen with other companies, that is not unique to TI.

And I suspect there's probably just different means by which different management teams will choose to extrapolate what they see going forward, and so I don't -- we've given what you we've given you.

We've explained the basis for it and what we've done.

And I guess I just need to let you sort it out in terms of how that compares to our other semiconductor peers.

Do you have a follow-on, Romit?

Does the fact that Q3 being 6 to 7 points below seasonal, does that have any bearing on how you think about the December and the March quarters?

No, too early for that at this time, Romit.

I might also add to remind you, even if we did have a seasonal growth, we still have an unwind of baseband going on.

So that's the $40 million sequential headwind, 2Q to 3Q.

If you adjust for that, we might not be down quite as sharply as you say, although they're still down versus what a seasonal number might suggest.

A seasonal number of 6% actually is ex baseband and refitted for the inclusion of National.

Okay.

Thank you.

Okay, Romit.

Let me also say, as we said before, if this market wants to lift on us versus the guidance we've provided, for Q3 or, frankly, even going into Q4, we have inventory position, we have manufacturing capacity, I think will you find our ability to flex up and support higher level demand, should it arise, that flexibility is pretty high.

So we really don't need to at least overly stress about what the outlook into Q4 will look like.

We'll work it as it comes toward us.

Thank you for your questions.

Operator, I think we have time for one additional caller.

David Wong, Wells Fargo.

You've talked in the past about how with Silicon Valley Analog, you've got a bigger sales team and more field presence.

Are you seeing any effect of this on design wins for the Silicon Valley Analog products, and if so, do you expect the growth of the SVA division to accelerate past your other analog divisions at some point in the future?

I think that's a reasonable expectation, David.

As you are implying in your question, right now it's more measured in customer interest and in design wins, and those then will be precursors to actual revenue growth that will occur later.

But we've long said our assumptions coming into this acquisition was that the share losses that National had experienced preacquisition likely would continue into the first year of the acquisition, and then we would hope to have the revenue stabilized and running consistent with the market and then for the next year, and then in year three basically have it trending faster than the market, consistent with our own analog growth.

So that would imply over the next couple of years you could see a faster acceleration in SVA growth, compared to TI's own revenue, just as it's coming kind of from a hole to moving consistent with our own revenue growth.

And I will also say, those assumptions that I just talked about were what we built into our financial returns and financial assessment on the acquisition.

Our internal goals, of course, are much more aggressive than that.

And we're confident at this point that just based on traction with customers, interest with customers, the design-in rates that we're going to be able to do better than that.

But we'll report it as it comes.

Do you have a follow-on, David?

Yes.

Your EPS guidance, does that assume any improvement in gross margins in the September quarter and if so is this mix related or is there some other factor that helps margin?

David, we mentioned early on in the call that there's some improvement inside there given that really the EPS is about flat quarter over quarter, revenue is about flat quarter over quarter at the midpoint.

So there's a little bit of improvement in there.

We'll see the wind down of the baseband, this lower margin being replaced by the calculator business at higher margin.

Okay, David, thank you for your questions.

And thank all of you for joining us.

A replay of this call is available on our website.

Good evening.

That does conclude today's call.

Thank you all for your participation.